Market Drivers in the Week Ahead

The US dollar began Asia on a firm note, but quickly succumbed to selling pressure.  The euro initially fell to almost $1.28, its lowest level since Sept 11, but rebounded smartly in late Asia and through the European morning.  The other major and emerging market currencies have generally followed suit.  That said, the short-term momentum indicators are stretched, suggesting the North American session will have difficult building significantly to the gains already scored.   Asian equities were mostly lower, with China, Hong Kong and Korean markets closed.  The MSCI Asia-Pacific Index lost about 0.4%, but European shares are broadly higher with the Dow Jones Stoxx 600 up about 1%, led by basic materials and financials.   Peripheral bonds are mostly firmer, while core bonds are heavier. 

There are three main issues that will vie for investors' attention in the week ahead:  the weakening of global growth, the policy response and political developments.  Although tail-risks were subdued in Q3, by the anticipation of ECB and Fed action, and its delivery, they are likely to re-emerge in Q4.

Weakening Global Growth:  All the major countries will have a turn this week to provide evidence of the continued vulnerability of the world economy.  The world's second and third largest economies have already delivered their somber news.  Japan's Tankan survey confirmed the deterioration in sentiment (-3 from -1), with a fourth consecutive negative reading.  China's official PMI remained below 50 for the second consecutive month.  Some of the details in China's report suggest the pace of the slowdown may be lessening as both new orders and export orders firmed, (though remained below 50).

The euro zone's flash PMI has already signaled an economic contraction in Q3.  The final report today confirms and the forward looking indicators like new orders (43.5 from 43.7), suggest the contraction will likely spill over into this quarter as well. The euro area PMI ticked up to 46.1 from 46.0 flash reading and 45.1 in August.  It is the 14th month below 50. 

Non-euro zone European countries also tended to disappoint.  The UK CIPS PMI fell to 48.4 from 49.6.  The consensus expected a 49 reading.  It is the fifth month below 50.  Export orders fell and manufacturers cut output for the third month.  Switzerland came in at 43.6 from 46.7, while the consensus had called for improvement.  Sweden's PMI fell to 44.7 from 45.1.  The consensus had expected a gain as well.  Norway did report a small rise to 48.9 from 48.8, but the market had expected more improvement.  The general theme holds:  weak outlook and firm prices. 

The US has reported a string of disappointing economic data.  The unexpectedly sharp drop in the Chicago ISM before the weekend warns of downside risks to the national manufacturing ISM later today.  The service sector is holding up better, perhaps owing to its reliance on the domestic economy, suffering less of from the global headwinds.  

Auto sales seem to be one of the few bright spots.  Auto sales in August are expected to be near a 14.5 mln unit pace.  This is well above the 13.1 mln average over the past 24 months.  Note that auto sales bottomed out in February 2009 at an annualized rate of 9 mln units.  

The highlight of the week is the US jobs report.  The Bloomberg consensus has drifted up a little in recent days to stand at 130k for the private sector.  The government is expected to have shed a net 15k positions.  The ADP estimate has not proven especially helpful lately, though if the August non-farm payrolls figure is revised higher (in line with what many had expected at the time), and its estimate this time (expected 145k), it could redeem itself.  

In some important ways QE3+ may take the near-term economic data out of play in the sense that nearly regardless of what it is, it is unlikely to show a significant and sustained improvement.  Therefore, the Fed remains on its path of unconventional easing of monetary policy through not only this year, but through next year as well.  

Policy Response:  Four central banks meet this week.  The Reserve Bank of Australia is the most likely to cut rates.  It is a close call.  The poor PMI reading (44.1 from 45.3) tilts the odds in the direction of a cut.  The recent RBA minutes appeared to open the door to easing, primarily, it seemed, due to risks emanating from the global economy, which have materialized.  Indicative pricing suggest the market is leaning slightly in favor of a cut, though opinion survey are less sanguine. 

The Bank of England meets.  The current gilt purchase program is projected to be completed next month.  A decision to extend the program is likely, while possible this week, is more probable next month, when it also issues its quarterly inflation report.  That said, the UK economy, which has contracted for the past three quarters, likely managed to post meager growth in Q3.  

The ECB will meet.  The macro-economic conditions justify lower a rate cut.  However, the ECB seems reluctant and the unexpected rise in the September flash CPI reading of 2.7% (Bloomberg consensus was 2.4%) reported at the end of last week, will give it cover. 

A subtext is because the ECB has knowingly gone against the Bundesbank and its hard money stance with its Outright Market Transaction program and  its liberal collateral framework, some concession must be made.  Even though the BBK has as many votes as say Cyprus or Luxembourg, it does not mean that it can be consistently out-voted and its interests violated.  Draghi's press conference will be of more interest than the ECB's decision this week, even if only filling in more details and providing more color.  

The Bank of Japan meets this week.  Since it just expanded its asset purchase program, it is too soon to expect a new move.   

Political Developments:  When one tries to evaluate the independence of central banks, the Hong Kong Monetary Authority is often seen at the top.  The Federal Reserve and the Bundesbank also get high marks. The BOE did not get its formal independence until 1998.  The BOJ frequently perceived to be less independent.  The justification for having an independent central bank is the concern that otherwise monetary policy would be at the whims of shortsighted politicians.  However, the less independent BOJ has not delivered higher inflation than more independent central banks.  In any event, with an LDP victory likely in the next election, the BOJ may see its leash tugged further by the new government.   

Spain's triple-debt challenge (sovereign, regions and banks) is morphing into a constitutional crisis.  Prime Minister Rajoy meets with regional leaders on Tuesday, but it will be difficult to diffuse the situation ahead of the local elections in Galicia and Basque Country on Oct 21.   Spain's faces 20.3 bln  euro bond (two bonds) maturities at the end of the month.  This will keep many anticipating a formal request for aid sooner rather than later.  

The Troika returns to Greece.  A couple of German publications apparently report the basis for a deal. It presupposes, as we have consistently argued, that the costs of a Greek exit can be too great.  The Troika will, according to the reports, present Greece's government with a list of reforms.  When parliament agrees to the reforms, the 31.5 bln euro tranche can be paid.   This seems unlikely to be completed before the Eurogroup summit on Oct 8.

The US holds its first presidential debate Wednesday.    With a campaign that appears to be faltering, Romney is seen to have to put in a strong showing.   Presidential debates are rarely the knock-out blow.  The Kennedy-Nixon and Carter-Reagan debates seem to be the exceptions that prove the rule.  

Lastly, we note that what has been regarded as one of the largest geopolitical risks--an Israeli strike on Iran--has eased following Israeli Prime Minister Netanyahu's speech at the United Nations.  The "red line" seems now to be next spring or summer.